Wednesday, December 28, 2016

What we're looking for in SaaS in 2017

As the year is coming to an end I’d like to share a few thoughts on what we’ll be looking for in the SaaS world in 2017. This is not meant to be an exhaustive enumeration but rather a brief outline of a few big themes that I feel particularly strongly about.

1) Viral growth and/or negative churn

In the last couple of years I’ve come to the opinion that in order to build a SaaS unicorn you need to have either (a) a highly viral customer acquisition engine or (b) significant negative net churn (that is, a dollar retention rate significantly above 100%). The rationale behind this statement, which might seem odd at first sight, is actually simple math. If you don’t have negative net churn you’re losing an increasing amount of MRR every month to churn, simply because your churn rate is applied to an ever-increasing base. That means that as long as you have positive net churn, you’ll have to add an increasing amount of new MRR from new customers every month just to offset churn. As you’re getting bigger and bigger it will become extremely difficult to maintain a high growth rate if you have to replace an ever-increasing amount of churn – unless you have an inherently viral product.

At a somewhat theoretical level, what I’m saying is that since net churn MRR grows as a function of your MRR base, you better have a mechanism that lets you add new MRR as a function of your existing base as well. I know this is a somewhat simplified way of looking at it and I’m sure there are a few exceptions to this rule, but I’m convinced that almost all SaaS startups that want to become big should strive for viral growth, negative churn, or both.

Companies like Slack or Zendesk have shown that a superior user experience can provide a decisive competitive advantage and can become a critical success factor for SaaS businesses. Pundits might object that you don’t win enterprise customers by having a prettier interface. I think that’s shortsighted for at least two reasons.

First, user experience is not only about making the UI more beautiful. As legendary UX expert Jakob Nielsen defines it, “user experience encompasses all aspects of the end user's interaction with a company, its services and its products”. An excellent user experience requires an elegant product that meets the needs of the customer and is a joy to use, but it goes beyond that. The design of your marketing website, the tone of voice of your marketing emails, interactions with customer service – all of this is part of the experience that you offer.

Second, today more and more buying decisions are made by the actual users of the software (e.g. someone in marketing looking for a marketing automation solution) as opposed to the IT department. When the buyer is also the user, usability becomes one of the key decision criteria.

This decentralization of software buying, which has led to the consumerization of enterprise software both from a product as well as a go-to-market perspective, is maybe the most important driver of change in the software industry that we’ve seen in the last 5-10 years. But it’s far from over. Millennials arguably have even less tolerance for slow, bloated, ugly enterprise software. If you grew up with UBER and Spotify, if you’ve never ordered a cab by phone and never went to a store to order a CD, chances are you expect your work software to work flawlessly as well. :-) As millennials continue to rise up the ranks, a focus on great design and a delightful user experience will become even more important for software companies.

Two of our most successful SaaS investments to date, Zendesk and Typeform, owe a large part of their success to what I like to call a “10x” improvement in user experience over the status quo. It will be extremely interesting to see which companies can accomplish a similar quantum leap in 2017 and how it will look like. Will it be a SaaS solution with voice as the primary form of input? A mobile-first SaaS app that truly leverages the smartphone’s camera, sensors and other applications to provide a 10x better user experience? Or a software with a conversational interface, powered by a bot? I don’t have the answer, but I’m pretty sure that new ways to input data – methods that are more natural than dropdown menus or smartphone keyboards – will be a part of it.

Up until recently, the main job of software was to make people more efficient by digitizing paper-based processes, doing calculations and enabling more efficient communication inside and between companies. This has led to huge efficiency gains, and I honestly have no idea how companies used to be operated without computers until 40-50 years ago.

And yet, the biggest disruption is still ahead of us. I am, of course, talking about artificial intelligence (AI). How long it will take until AI will reach human intelligence – or if that’s never going to happen – is an extremely interesting topic that goes far beyond the scope of this post (and of course one that I’m not an expert in). It’s safe to assume, though, that software is getting better and better at more and more tasks which were previously thought to be impossible for computers to learn. Watson’s victory against two “Jeopardy” champions a few years ago and AlphaGo’s win against one of the best Go players are two legendary examples, but there are lots of other, less publicized cases, of computers winning against humans.

If close to 50% of jobs will be done by computers in the not too distant future, as an Oxford University study suggests, this will of course have unprecedented consequences for our society. How those consequences will look like, and if the net impact will be positive or negative for most people, is another extremely interesting topic that I’m not going to delve into here. What’s clear is that this disruptive force will create enormous opportunities for SaaS companies.

With today’s software it can sometimes be hard for a SaaS startup to prove the ROI of its product to prospective customers. Putting a dollar sign on the efficiency gains that a customer can realize by using your software can be difficult, and your product may provide lots of pretty intangible benefits that are hard to quantify. Now imagine that your SaaS solution allows your customers to get work done with significantly less people or maybe no people at all. In that case, the ROI will be pretty obvious.

What if future versions of sales automation software will not make your sales force more efficient but become your sales force? I can’t imagine how bots could take over sales calls … or wine and dine with a client. :) But think about jobs like web-based prospecting, lead qualification or email campaigns and the idea starts to sound a lot less far-fetched.

Although we developed a strong interest in AI in the last few years we have not yet seen a large number of “AI startups” that we fell in love with (one notable exception is our portfolio company Candis, which is automating accounting work). This could be because the industry is still at a nascent stage or because it’s still early days for us in terms of learning and developing an investment thesis around AI, or both. In any case, we’re excited to spend more time on this topic in the coming year!